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The Importance of Reporting Incentives: Earnings Management in European Private and Public Firms

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Center for Financial Studies (CFS); University of Pennsylvania - Wharton Financial Institutions Center; CESifo Research Network

This paper examines how capital market pressures and institutional factors shape firms' incentives to report earnings that reflect economic performance. To isolate the effects of reporting incentives, we exploit the fact that, within the European Union, privately held corporations face the same accounting standards as publicly traded companies because accounting regulation is based on legal form. We focus on the level of earnings management as one dimension of accounting quality that is particularly responsive to firms' reporting incentives. We document that private firms exhibit higher levels of earnings management and that strong legal systems are associated with less earnings management in private and public firms. We also provide evidence that private and public firms respond differentially to institutional factors, such as book-tax alignment, outside investor protection and capital market structure. Moreover, legal institutions and capital market forces often appear to reinforce each other.

Date posted: March 23, 2006
; Last revised: November 20, 2011

Suggested Citation

Burgstahler, David and Hail, Luzi and Leuz, Christian, The Importance of Reporting Incentives: Earnings Management in European Private and Public Firms. Accounting Review, Vol. 81, No. 5, pp. 983-1016, 2006. Available at SSRN: http://ssrn.com/abstract=890648